Welcome back to another episode. Name a financial arrangement or system where current investors’ profits are dependent on cash from new investors. If you said Ponzi scheme, you would be correct. But if you said publicly traded stocks, you would also be correct. But before I explain why stocks are a Ponzi, let me first make a distinction. I’m not saying all stocks are Ponzi’s, just the ones that perpetually don’t pay dividends. Why is that?
Well, there’s two ways. Investors can make money in stocks. One is from dividends and the other is to capital gains by selling the stock in the future for more than the purchase price. If a company doesn’t pay dividends, the only way their investors can profit is from new investors willing to pay a higher price, which sounds like a Ponzi scheme. Companies that don’t pay dividends haven’t established a history of consistent profitability, and frankly, don’t have the confidence to make the dividend payments. Their stock prices rise and fall at the whim of investors. Dividend paying stocks on the other hand are not Ponzi’s because the companies paying them are legitimate businesses with a history of profitability.
Their stock has an intrinsic value independent of the market price of the stock. In other words, the investor will still receive their dividends as long as they hold the stock no matter what the price is on the stock market. Dividends stocks are rooted in profitable enterprises, capable of paying those dividends. Delta airlines, Intel, Walmart, Apple, Coca-Cola are great examples of companies that pay dividends. They are all long running businesses and have a history of profitability. Dividend paying companies pay their investors from profits. Dividendless companies do not pay investors at all. Investors must rely on the greater fool theory to make money with these stocks, making them speculators. Buying, and trading in the hopes of picking up a bargain from one fool and turning it around and selling it for a profit down the road to a greater fool. This is what makes for a volatile stock market.
Here’s why, because a substantial amount of market capitalization of the stock market is not rooted in sound financial principles, but on speculation and the wealth in the stock market is Phantom wealth. Investors are continually chasing the next Facebook or Amazon frequently buying and dumping stocks in pursuit of the next best thing. And usually a company that has never been profitable, I’m looking at you Snapchat. Here’s a prime example of Phantom wealth. Uber’s market cap currently sits around $57 billion, but it has yet to turn a profit and has no prospect of turning one anytime soon. The market cap is based on hopes and dreams and in a market downturn, those hopes, and dreams will be dashed. This is the reason the market cap of the stock market vaporized during the last financial crisis. And we’ll
do it again during the next financial crisis. It’s because cash is king during a crisis and investors in non-dividend paying stocks will be happy to unload the mystical rainbows and unicorns for cold, hard cash. Even if it’s a lot less than they initially paid for that stock. That’s why the Ponzi nature of stocks makes the market dangerous and volatile.
The problem with the stock market is that dividendless paying stocks are the ones that get all the attention. Dividend paying companies are usually older, involved in unsexy businesses. The whole buy-low sell-high gamble is the only game that’s being talked about on Fox business, CNBC and financial news networks, and is also the focus of a lot of financial analysis and research. The rise and fall of stocks are all these financial news sources talk about because they think that’s all investors want to hear. It’s a fact that dividend paying stocks are hit less hard than other stocks during downturns because of the intrinsic value of the dividend stream. However, dividend stocks are not entirely immune to the stress. Even during the most significant crisis, like the last one, some dividend paying companies scaled back their dividends or suspended them altogether.
My point is the stock market is volatile and much of its “wealth” is Phantom and can come and go in an instant. Nothing’s safe in the stock market in a downturn. So why invest in something rooted in a shaky foundation, investors like dividends for the fixed type income they provide. So why not consider another type of investment offering consistent periodic income distributions rooted in an established industry that is not tied to stock market volatility. It’s not sexy or new or the next best thing, but why not consider an alternative investment like real estate? Ultra-high net worth investors are always prepared for recessions. That’s because the vast majority of their investible assets are not tied to the stock market. They prefer alternative assets like real estate that offer consistent income distributions and are asset back and resistant to market downturns. Ultra-high net worth investors have long allocated, more than 10% of their investible assets in commercial real estate for those reasons alone, such as affordable housing are not only resistant to downturns, but actually thrive in them. With the passage of the jobs act secure alternative investments are no longer exclusive to the wealthy. They are readily accessible to more qualified investors than ever before. And there’s no excuse for serious investors not to break the vicious cycle of the wall street Ponzi scheme and invest in something tangible in volatility free like commercial real estate.